This note looks at the surge in budget deficits and public debt now underway in Australia and around the world in response to the global financial crisis and economic slump. Specifically, will this just push up inflation and bond yields (and hence broader interest rate levels)? The key points are as follows:

– Fortunately, Australia is in a better position than most countries to increase public borrowing, having a starting point of zero net public debt.

– Fears that soaring budget deficits will simply push up inflation and bond yields are likely to be misplaced in the short term. Increased public borrowing will be offset by increased private sector saving and reduced private borrowing as consumption and investment weaken.

– However, the key will be for governments to wind back their borrowing and debt as economic recovery kicks in.

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